What goes up must come down
Spinning Wheel got to go 'round
Talkin' 'bout your troubles
It's a cryin' sin
Ride a painted pony
Let the Spinning Wheel spin
You got no money, you got no home
Spinning Wheel all alone
Talkin' 'bout your troubles and you
You never learn
Ride a painted pony
Let the Spinning Wheel turn
-- Blood Sweat & Tears, Spinning Wheel
The expression, "what goes up must come down" means that something with a meteoric rise to power or fame will eventually experience a fall from grace. It is a way of saying that parabolic growth is unsustainable and sooner or later, everything comes back into balance.
As the legend goes: Sir Isaac Newton, an English mathematician, physicist and philosopher, was sitting under an apple tree when an apple fell on his head. This falling apple made Newton suddenly realize that something must be pulling the apple down towards the Earth and he thought up the Universal Law of Gravitation.
Many years later -- 1968 to be exact -- Blood Sweat & Tears' David Clayton-Thomas was living in Yorkville, Ontario (the bohemian rock music epicenter of Toronto, similar to Greenwich Village in Manhattan) and down the hall from Joni Mitchell. Smitten by the songstress and inspired by her song The Circle Game (he took her line about "painted ponies"), he wrote Spinning Wheel. Written in an age when psychedelic imagery dominated song lyrics, it was Clayton-Thomas' way of saying, "Don't get too caught up, because everything comes full circle."
Full Circle
In recent weeks I have expressed multiple fundamental concerns on my Daily Diary on Real Money Pro. I have warned about rising interest rates (a Fed that will not cut this year and will likely stay higher for longer), "slugflation" (slowing economic growth and sticky inflation), a meaningful pivot by hedge funds (from defensive to aggressive market positioning), elevated valuations and the threat implicit in the market's speculative tone:
* My Longer Term Market Outlook
* Emotion Takes Over the Market - As "TINA" Takes a New Form
* The Pathway to AI Adoption and Profits Will Likely Be Rockier Than Many Expect
Our Greatest Concern - Rising Interest Rates
In Wednesday's Bloomberg interview Surveillance: Yield Curve with Peters - Bloomberg with Tom Keene I highlighted my concerns about interest rates:
"At yesterday's close the Federal Funds Rate stood at 5.08%, the six month treasury note yielded 5.45% (roughly 3.5x the S and P dividend yield of 1.65%), a fixed rate mortgage is over seven percent, the S&P Index closed on Tuesday at 4,145 and the consensus 2023 S&P EPS is projected at $224/share (which we view as too optimistic (in light of 1Q eps of only $53/share))!
This compares to fifteen months ago (on 2/24/22 ) when the Federal Funds Rate was at only 0.08%, the yield on the six month note was 1% of roughly 2/3 the S and P dividend yield, a fixed rate mortgage was under three percent, the S&P Index closed at 4,117 (only 1/2% away from Tuesday's close) and when the forecasted 2023 S&P EPS was projected to be considerably higher (at $244/share).
Remember 2023 S&P EPS estimates peaked at $252/share in June, 2022 and have come down by over ten percent to $224. So, the S&P seems highly valued especially against interest rates and a reasonable and much lower forecast of S and P profits."
Briefly, here are some more concerns on the interest rate front:
The equity risk premium -- the inverse of the price earnings multiple -- hasn't been this slim since October 2007. Then, the S&P 500 was at its pre-Great Financial Crisis peak, and fed funds traded at 4.8%. Stocks dropped 45% in the next year & the Fed slashed rates:
Real interest rates on two-year Treasury notes are approaching the levels last seen in 2009:
Since March 2023 stocks and bonds have meaningfully diverged:
The Nifty Five Comparison to The Nifty Fifty
I have compared the 2023 AI speculation and the, arguably, sky-high valuations of The Nifty Five leadership of only five large-cap tech stocks to the similar conditions that existed with The Nifty Fifty era that ended abruptly in 1974 and led to seven lean market years.
But, today's concentrated market leadership is even more exaggerated as it entails only five stocks -- at least The Nifty Fifty consisted of 50 different stocks. As well, The Nifty Fifty encompassed multiple industries (cosmetics, photography, entertainment, industrial, leisure, soap, food, etc.) -- the Nifty Five comprises only technology, and the stocks are catalyzed by the even more narrow AI focus/exposure/frenzy. Here is an incomplete but representative list that demonstrates the broad industry participation of The Nifty Fifty:
* Philip Morris
* Pfizer
* General Electric
* Coca-Cola
* PepsiCo
* Revlon
* McDonald's
* The Walt Disney Company
* Merck
* Procter & Gamble
* Eli Lilly
* Johnson & Johnson
* American Express
* Dow Chemical
* Texas Instruments
* Xerox
By contrast to the leadership in the 1960s and early 1970s, today's constituents of the current market leadership is only one-tenth the size --measured by number of (5) members) -- and revolves around only one industry, AI:
* Nvidia (NVDA)
* Microsoft (MSFT)
* Apple (AAPL)
* Google (GOOGL)
* Meta (META)
Year to date, the contribution of the 10 largest stocks in the S&P Index to the Index's total performance has never been as extreme at 95.6%):
Put another way, this year represents the lowest number of S&P stocks beating the market since March 2000!:
The Nasdaq is outperforming the Dow Jones Industrial Average this year by an entire bull market!:
A profound change in market structure has exaggerated the narrow leadership in 2023. Unlike 50 years ago, when active investing populated the investment landscape, passive investing and the dominance of price momentum-based products and strategies (ETFs and quant strategies) have contributed mightily to the narrowness of this year's market advance and an unprecedented top heavy market.
Let's now examine the extremely concentrated market leadership from several timeframes -- Wednesday, the last week, the past three months and year-to-date.
Thursday's divergence between the Nasdaq and the other averages was among the most severe and conspicuous ever:
Today was a 68% downside day - with the SPX up >1%. DVOL>UVOL on the Naz, too.
Obviously, it's a Buffalo Springfield market:
"Something's happening here;
- Walter Deemer (@WalterDeemer) May 25, 2023
What it is ain't exactly clear..."
The compare is also startling from the last week's perspective -- as over the last five trading sessions only three ( (QQQ) , (XLK) and (PIN) ) of the 61 largest ETFs were up, while the average (week over week change) was -2.15%:
Now let's look at the three-month performance spread between the S&P Index and the S&P equal weighted Index -- it is at the widest spread since late December, 1999:
Here is a year-to-date compare (from Bespoke) which illustrates that the "market ex AI" looks quite different than "the market" right now:
Over time (and over history), narrow market always mean revert:
Here is a chart of the QQQ ETF without technology:
Bottom Line
And I feel like I've been here before
Feel like I've been here before
And you know, it makes me wonder
What's going on under the ground
- Crosby Stills Nash & Young, Deja Vu
Today's "Nifty Five"' is more concentrated in names and industry exposure than "The Nifty Fifty"' era of the late 1960s and early 1970s.
An unprecedented "top heavy" market, dominated by a handful of high-tech equities that have as a theme, AI, will either broaden out or die.
We believe the Nasdaq-led rally of the Nifty Five in 2023 will end badly, just as the Nifty Fifty did in 1974.
The uber-concentrated market leadership (embraced by AI/enthusiasm fever), the 15-month rise in interest rates (and no Fed rate cut likely in 2023), "slugflation" (sticky inflation and rapidly slowing global economic growth), the more aggressive (and offensive) long positioning (on the part of hedge funds) and elevated valuations present headwinds argue in favor of a market death over a broadening out of upside participation.
From our perch it is likely that the S&P Index is at or is approaching a top for the year.
Look what' s going on under the ground. We have all been here before.
But many investors and -- in the near breathless business media -- have forgotten.
Think Isaac Newton.
